5 Most Important Concepts in Finance
The world of finance comes easy to some people, but for many, it can be a completely foreign concept. If you’re one of the millions of people that’s trying to learn more about finances so that you can understand the market while also helping out your own bank accounts, there are certain things to know. Here are five of the most important concepts in finance to familiarize yourself with so that you can get a better general understanding.
1. Inflation
Prices go up every year, whether or not wages do, and this is the result of inflation. Inflation varies by year and can be to the point where certain things can become unaffordable for a lot of people. Grocery and gas prices are the most obvious victims of inflation, though mortgage and rent prices are the ones that have the biggest impact on the general population.
Inflation can be a good thing for the economy and personal finances if it’s incredibly slow and steady. When this occurs, wages tend to grow with inflation, but inflation rates increasing too quickly has a negative impact on businesses and employees. The worst case of inflation that the world has ever seen came from Hungary in the early 20th century.
2. Bull/Bear Market
You may have heard about bull and bear markets or even seen the multiple statues of the two animals fighting each other. These animals represent the stock market, both good and bad, but why these particular animals? The bull represents a thriving economy where unemployment drops while securities and wages increase.
The reason for this is because when a bull attacks, it uses its horns in an upward thrust. As for the bear, he attacks with a downward swiping motion. You’ll hear about rising interest rates and increased unemployment during a bear market as people start to sell off a lot of their stocks.
3. Debt-To-Income Ratio
While credit scores are often considered to be the most important part of getting a large loan like a mortgage, many don’t realize that their debt-to-income ratio is just as important. Your DTI ratio is a comparison of how much you earn each month compared to how much you have in monthly payments.
All of your monthly bills are taken into consideration when calculating DTI. Your rent or house payment will be the biggest one, followed by loan and credit card payments. This can include student loans and car payments. Other debts are taken into consideration, including court-appointed payments like alimony or child support, but your monthly utility bills are not included.
4. Interest
Interest is one of those things that can be very confusing to beginners as there are a lot of different forms of interest. From interest paid on loans to interest accrued from savings, there is a lot of interest in, well, interest. Two of the major forms of interest are simple interest and compound interest.
Simple interest doesn’t have a lot of frills attached to it, hence the name. Simple interest has a fixed percentage that accrues from a balance each month. Compound interest, on the other hand, is calculated using both initial principal and previously accumulated interest. It isn’t as complicated as it sounds, though, thankfully.
5. Net Worth
The world has a fascination with finding out someone’s net worth. After all, almost every one of us has looked up a celebrity or businessperson’s net worth on Google. While it’s almost impossible to get a 100% accurate net worth for someone that’s worth millions, we can at least get a good idea.
For individuals, finding out their net worth is much easier. It’s a bit more in-depth than the debt-to-income ratio but uses many of the same statistics. All assets are taken into consideration when determining net worth, including companies owned, real estate, and anything else that’s tangible. Then, all of the liabilities are subtracted including all loan balances. It’s estimated that more than 10 percent of Americans have a negative net worth.